George Akerlof

George Akerlof is a professor at the University of California, Berkeley. He won the 2001 Nobel Prize in Economics (shared with Michael Spence and Joseph E. Stiglitz) for his paper “The Market for Lemons: Quality Uncertainty and the Market Mechanism.” Akerlof has worked to incorporate human psychology into economic models since 1970. His recent publications include Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Explorations in Pragmatic Economics and Thoughts on Global Warming. He spoke with ecological economist Tom Green about what’s missing from mainstream economics.

Although economics has progressed in the last 50 years, important aspects of human motivation are still missing from it. I am trying to effect a return to a more sensible and pragmatic economics. Until recently, simplistic assumptions about human behavior have misled theory and misguided policy. We need to once again base our models on, as Keynes put it, “our knowledge of human nature and ... the detailed facts of experience.” We now know that people often do not behave rationally. What we need to include in economic models are the norms and motivations that guide human behavior. People have very firm notions about how they and other people should behave, although they often don’t know exactly where these notions come from. Economics has eschewed this kind of motivation and, as a result, it’s more solemn than it should be, and it’s also a lot less fun. There are many issues in which economics could offer more powerful analysis, and there are many issues in which it gets the wrong answer. It claims that it has insights, but these insights are wrong.

If you go back 40 or so years, norms and motivations would have been part of economists’ analyses. Then an intellectual movement which said we should be much more scientific and derive everything from principles of maximization arose. For some reason or other, the notion that people actually care about how we should or shouldn’t behave got left out of the methodology. Economists tried to make their models very simple and, as a result, we have a less good economics than we would have had otherwise.

Models that are restricted to economic motivations make it very difficult to explain such important phenomena as inflation. It’s also very difficult to explain why the monetary authority has an effect on the level of employment and output and to explain the trade-off between inflation and unemployment. The same type of problem applies to many different areas of microeconomics. We lose a lot of the explanation of how organizations work, we lose a great deal of the economics of gender, we lose a lot of the economics of minority poverty – especially why minorities tend to have high levels of poverty.

Part of the problem arose back in 1953, when Milton Friedman urged his fellow economists to rely on parsimonious models, simple models, that explain the world with a minimum of variables. Parsimony was erroneously defined as making models dependent on what we consider to be economic arguments – how individuals seek to maximize their utility and what gives them utility – is narrowly defined and mainly focused on consumption. The interpretation of parsimony shouldn’t include the idea that norms don’t matter, because in fact norms really do matter.

Economists have to start adding norms and motivations back into their models. People have some kind of view as to how they should be behaving. What makes us happy is largely whether we feel we live up to that view. The way economics is sometimes taught suggests the path to well-being is maximizing consumption opportunities, creating opportunities for the economy to grow so consumers can consume more. But this model has shortcomings. Economists have contributed to the shortcomings by missing the inclusion of norms and motivations. Once you’ve met some basic needs, what makes you happy is having a view of what you should be doing ... and doing it.